Am I reading the following signs from investor correctly?

We are an Internet startup, and we're trying to raise a $100K pre-seed round from a private investor at a valuation of $2.5M. We already have a working prototype, but no customers yet, no patents, and no "sharks" on the team (no mentors either).

After two months of negotiations via a middleman (a mutual friend), the investor hasn't provided any term sheet and yesterday asked if the price/valuation could be reduced (to which my partner said "no"). On the other hand, according to the middleman, the investor is "excited" about this opportunity and wants to invest.

Now, my instincts scream out loud that all of the above signs are super-bad, including the supposed "excitement" (in my experience, a really interested investor would be more judgmental, critical, and nervous rather than excited). I argue that the chances for investment in this case are slim to none, and we should stop wasting our time on this investor (actually, I don't see any reason for an investment at this stage at all, but that's another story).

But my partner thinks that we are at "advanced stages of negotiation" and that the round will be closed soon on our terms.

Am I wrong to be pessimistic? Is is possible that my partner is right?

Anonymous

July 1st, 2015

Hi, Dimitry.

Are you in the US? I don't know about other countries, but it seems bizarre to be talking to investors through a "middleman". AFAIK (from my own experience raising money and general knowledge), most competent investors (angel or VC) here in the US don't work this way. They work directly with founders. Typically, the only thing close to a "middleman" is the person who makes the intro (and immediately gets out of the picture) or, if you're not a founder, a founder.

Also, what have you been negotiating for two months if you have no term sheets from the investor?

Are you a founder? If so, why be forced to raise money if you don't think it's needed?

Lastly, if you're pre-seed, why the valuation? $100K sounds like a convertible note deal to me.

1. If you want to be a founder, and have the leverage, do so in terms of ownership, not just in name. And make sure you're on the same page with your co-founders in the areas of organizational culture, risk tolerance, end goals (IPO, acquisition, run as a hobby? valuation?), and more.You can find other questions to ask online.

2. If you intend to stay with the company, ask to meet the investor, at least by phone, ideally in person.

a. If not allowed, ask for the reason.

b. If the reason is dumb or bad, add that to the RUN AWAY side of the ledger.

3. If you like the investor, reconsider that $2.5M valuation. It does feel high, at least on the facts you gave us. Many, many startups have foundered on the ego- (not market-) driven nature of the first valuation.

4. Find out what, exactly, has been in "advanced negotiations" for so long - and in any event make sure you have a contract with a provision stating your partner warrants that all representations about ownership, number of investors, number of co-founders, etc. are true and accurate.

5. Ask your partner to defend his reasoning for seeking financing. Give him your view. Back it up with examples, facts, reason. Once you've talked to one another, consult some mentors, or come back here.

6. Larry means well, but I believe he jumped the gun on deciding what was in your head. I read "I may be right" as an expression of both relief and concern that your hunch has been validated by others, and now what?? Larry, we love you.

Customers always create more value and traction.
With a working prototype there's really no reason
not to be beta testing with 5-10 small vendors.
We know your product is bullet proof, but until it flies
in the real world under actual customer stress, you're
still blindfolded. Get some feedback from your clients,
then you're much more confident in your idea, and when
negotiating with Angels and Seed funds.
Best
-Andrew Meadors
digirithm
"Analyzing the world's data"

> With all due respect, your last comment, "So I may be right after all" is troubling

> because it implies that you value being right over getting to success.

I think you misunderstood. I believe that we should forget about this investor (and fundraising in general for now) and concentrate on the product and the market. I intend to convince my partner of this. If I'm right, then this will greatly improve our chances for success. But if I'm wrong and my partner is right, then I will cause us to lose a certain investment.

In other words, me being right and getting to success happens to be one and the same in this case. Ego has nothing to do with it.

You do not provide sufficient information to allow an informed judgement.
Have you met with the investor? if so how many times? What was the tone
of the discussions. What were the subjects. If there has been no meeting
with the investor and all communications are through an agent you are on a
hiding to nothing.

A lot of good stuff has been said already. My 2 cent:1) Never use a middleman for company investments - good investor never invest through middleman and bad investors you don't want - even or in particular if you are desperate.

2) Make sure you can fully trust your partner - if there is a doubt or you don't feel to well about it, talk to each other and then strengthen the relationship or cut it off. Better a pain to end it than never ending pain.

3) Look for a mentor in your region you can trust and who has experience with building successful startups.4) Review your company valuation. The value of your business must sustain two major contradicting forces: a) What you think it is worth based on comparing your business in your region with others, your own intuition and the bold long term vision/opportunity on one side - and b) what the "market" meaning investors are willing to pay.

Dimitry,
Optimistic or pessimistic too much emotion. You said you don't need the money are you testing the waters? What do you plan on doing with the money if you get? Sounds like the team needs to get on the same page Identify milestones and create a plan with timelines before you start taking money with no plans for it's use. Anyway I think you're right I wouldn't be waiting to reel this one in the line is obviously snagged. Aaron